Q & A on company liability for wrongful acts of employees

When will the acts or knowledge of an employee be attributed to his employer?

It mainly depends on the type of liability – e.g. criminal or civil, under statue or in tort – and the relationship between the employee and the board. Because of the variety of possible circumstances, the courts have applied a number of different principles.

Can you be more specific?

For criminal offences, a company will generally only be liable if the person who was in practice responsible for the act or omission can be identified as the ‘directing mind and will’ of the company. Usually, this is only likely to apply to the managing director, or another key board member, but it could include someone below board level who has significant decision-making authority. This is also the test for the existing offence of ‘corporate manslaughter’.

What about fraud committed by employees?

In fraud cases, the critical issue is often whether the board had sufficient knowledge of the circumstantial evidence. Knowledge is not necessarily confined to actual knowledge: it could include ‘constructive’ or ‘imputed’ knowledge – i.e. what someone ought to have known; collective knowledge of a group of people; and even ‘blind-eye knowledge’ – i.e. deliberately turning a blind eye to something you have concrete grounds to believe is suspicious.

So could a company be liable if an employee turns a blind eye?

Yes. In June, the liquidators of BCCI obtained over £40m compensation from the Bank of India on the grounds that the manager of BOI’s London branch had at least ‘blind-eye’ knowledge that various transactions with BCCI were for a fraudulent purpose. BOI was held liable under section 213 Insolvency Act 1986 even though the branch manager was not a board director and there was no evidence that BOI’s board were dishonest. Although the board had approved the first transaction on the basis that it was to be a one-off, in practice they had allowed the branch manager complete discretion to enter into further similar transactions. Since the section is designed to make those who are parties to fraudulent trading compensate the company’s creditors, its purpose would be defeated if the liquidators had to show that the board of BOI actually knew of the fraud themselves.

What about liability in tort?

Generally speaking an employer is vicariously liable for torts committed by agents and employees in the course of their employment or where they act within the scope of their actual or ostensible authority. For example, last month a Canadian subsidiary of Daimler-Chrysler was held vicariously liable to the purchaser of one of its businesses for fraudulent misrepresentations about the target’s accounts made by its financial controller, who was leading the sale negotiations on behalf of the seller.

What factors make it more likely that a company will be liable?

The employee’s level of seniority; the amount of discretion given to him free of regular supervision or control by the board; the extent to which the act falls within his actual or ostensible authority; and the degree to which the board is informed and put on inquiry. In the latter case, the more unusual and valuable the transaction is, the more the board is expected to ask pertinent questions and to assess answers critically. Failure to do so makes it more likely that the employee will be treated as the ‘directing mind and will’ of the company at least for purposes of that transaction. With statutory offences, the courts will also try to give effect to the underlying policy: in some cases this can even result in companies being liable for acts carried out by employees in direct contravention of board instructions.

First published in Directors' digest November 2005, a CMS Cameron McKenna publication.